PureCompetition

Chapter 9

Four Market Models

• Pure competition• Pure monopoly• Monopolistic competition• Oligopoly

Market Structure Continuum

PureCompetition

MonopolisticCompetition Oligopoly

PureMonopoly

Imperfect Competition

9-2

Pure Competition

1. Very large numbers

2. Standardized product

3. “Price takers”

4. Free entry and exit9-3

Pure Competition• The demand schedule faced by an individual

form is perfectly elastic at the market price

• The demand curve for the market is still downward slopping

–Average revenue

–Marginal revenue

–Price

9-4

Pure Competition• Average revenue

– The individual demand schedule is also AR since the price per unit is the Revenue per unit

• Marginal revenue– In pure competition, MR=P

• TR– Slopped upwards, constant slop since

addition in TR is equal to P9-5

Firm’sDemandSchedule(AverageRevenue)

Firm’sRevenue

Data

Pure Competition

Pri

ce a

nd

Rev

enu

e

2 4 6 8 10 12

131

262

393

524

655

786

917

1048

$1179

Quantity Demanded (Sold)

D = MR = AR

TR

P QDTR MR

$131131131131131131131131131131131

0123456789

10

$0131262393524655786917

104811791310

$131131131131131131131131131131

]]]]]]]]]]

9-6

Short Run Profit Maximization

• Market price is given

• Three questions:–Should the product be produced?

–If so, in what amount?

–What economic profit (loss) will be realized?

9-7

Profit Maximization

• Two approaches

1. Total revenue and total cost approach–Produce where TR-TC is greatest

2. Marginal revenue and marginal cost approach–Produce where MR=MC

9-8

Total Revenue Total Cost Approach

(1)Total Product(Output) (Q)

(2)Total FixedCost (TFC)

(3)Total Variable

Cost (TVC)

(4)Total Cost

(TC)

(5)Total Revenue

(TR)

(6)Profit (+)

or Loss (-)

Price = $131

0123456789

10

$100100100100100100100100100100100

$090

170240300370450540650780930

$100190270340400470550640750880

1030

$0131262393524655786917

104811791310

$-100-59-8

+53+124+185+236+277+298+299+280

Now Let’s Graph The Results…Do You See Profit Maximization?9-9

10 2 3 4 5 6 7 8 9 10 11 1213 14

10 2 3 4 5 6 7 8 9 10 11 1213 14

$180017001600150014001300120011001000

900800700600500400300200100

$500400300200100

To

tal

Re

ven

ue

and

To

tal

Co

stT

ota

l E

con

om

icP

rofi

t

Quantity Demanded (Sold)

Quantity Demanded (Sold)

Total Revenue, (TR)

Break-Even Point(Normal Profit)

Break-Even Point(Normal Profit)

MaximumEconomic

Profit$299

Total EconomicProfit

$299

P=$131

Total Cost,(TC)

Total Revenue Total Cost Approach

9-10

Marginal Revenue Marginal Cost Approach

(1)Total

Product(Output)

(2)Average

FixedCost(AFC)

(3)AverageVariable

Cost(AVC)

(4)Average

TotalCost(ATC)

(6)MarginalRevenue

(MR)

(7)Profit (+)

or Loss (-)

0123456789

10

$100.0050.0033.3325.0020.0016.6714.2912.5011.1110.00

$90.0085.0080.0075.0074.0075.0077.1481.2586.6793.00

$190.00135.00113.33100.00

94.0091.6791.4393.7597.78

103.00

$131131131131131131131131131131

$-100-59-8

+53+124+185+236+277+298+299+280

No Surprise - Now Let’s Graph It…Do You See Profit Maximization Now?

(5)Marginal

Cost(MC)

$90807060708090

110130150

9-11

Co

st a

nd

Rev

enu

e$200

150

100

50

01 2 3 4 5 6 7 8 9 10

Output

Economic Profit MR = P

MCMR = MC

AVC

ATC

P=$131

A=$97.78

Marginal Revenue Marginal Cost Approach

9-12

Short Run Profit Maximization

• Produce where MR (=P) = MC

• Suffer loss, still produce?

• Yes if loss is less than fixed cost–Cover variable cost

• Shut down if loss greater than fixed cost

• Produce if P > min AVC9-13

Lower the Price to $81 andObserve the Results!

Co

st a

nd

Rev

enu

e$200

150

100

50

01 2 3 4 5 6 7 8 9 10

Output

Loss

Short Run Loss Minimizing Case

MR = P

MC

AVCATC

P=$81

A=$91.67

V = $75

9-14

Lower the Price Further to $71 and Observe the Results!

Co

st a

nd

Rev

enu

e$200

150

100

50

01 2 3 4 5 6 7 8 9 10

Output

Short Run Shut Down Case

MR = P

MC

AVC

ATC

P=$71

Short-Run Shut Down Point

P < Minimum AVC$71 < $74

V = $74

9-15

Short-Run Supply Curve

Continuing the Same Example…

Supply Schedule of a Competitive Firm

PriceQuantitySupplied

Maximum Profit (+)or Minimum Loss (-)

$151131111

91817161

10987600

$+480+299+138

-3-64

-100-100

The schedule shows the quantity a firmwill produce at a variety of prices

9-16

Short-Run Supply Curve

Firms produce where MR=MC

P1

0

Co

st a

nd

Rev

enu

es (

Do

llars

)

Quantity Supplied

MR1

P2 MR2

P3 MR3

P4 MR4

P5 MR5

MC

AVC

ATC

Q2 Q3 Q4 Q5

This Price is Below AVCAnd Will Not Be Produced

ab

c

d

e

9-17

Short-Run Supply Curve

P1

0

Co

st a

nd

Rev

enu

es (

Do

llars

)

Quantity Supplied

MR1

P2 MR2

P3 MR3

P4 MR4

P5 MR5

MC

AVC

ATC

Q2 Q3 Q4 Q5

ab

c

d

e

MC Above AVC Becomesthe Short-Run Supply Curve S

Examine the MC for the Competitive Firm

Break-even(Normal Profit) Point

Shut-Down Point (If P is Below)

Firms produce where MR=MC

9-18

Firm and Industry Supply

• Changes in firm supply–Shifts in marginal cost

–Input price or technology

• The industry (total) supply curve–Sum of individual supply

• Industry supply and demand–Determine market price

9-19

Single Firm Industryp P

p P0 0

Firm and Industry Supply

EconomicProfit

d

ATC

AVC

s = MC

$111 $111

D

S = ∑ MC’s

8 8000

Competitive firm must take the price that isEstablished by industry supply and demand

9-20

Long Run Profit Maximization

• Assumptions–Entry and exit only–Identical costs–Constant-cost industry

• Goal of the analysis–In the long run, P = min ATC–Entry eliminates profits–Exit eliminates losses

9-21

Single Firm Industryp P

p P0 0100 90,00080,000 100,000

Entry Eliminates Profits

ATC

MR

MC

$60

50

40

D1

S1

An increase in demand temporarily raises priceHigher prices draw in new competitorsIncreased supply returns price to equilibrium

D2

$60

50

40

S2

9-22

Single Firm Industryp P

p P0 0100 90,00080,000 100,000

Exit Eliminates Losses

ATC

MR

MC

$60

50

40

D3

S3

A decrease in demand temporarily lowers priceLower prices drive away some competitorsDecreased supply returns price to equilibrium

D1

$60

50

40

S1

9-23

Long Run Supply

• Constant cost industry–Entry/exit does not affect LR ATC–Constant resource price–Special case

• Increasing cost industry–Most industries–LR ATC increases with expansion–Specialized resources

• Decreasing cost industry9-24

P

0 Q

Long-Run Supply Curve

Constant-Cost Industry

90,000 100,000 110,000Q3 Q1 Q2

$50

P1

P2

P3

SZ1 Z2Z3

D3 D1 D2

9-25

P

0 Q

Long-Run Supply Curve

Increasing-Cost Industry

90,000 100,000 110,000Q3 Q1 Q2

$50P1

S

Y1

Y2

Y3

D3

D1

D2

$40

$55P2

P3

How would a decreasing-cost industry look?9-26

Pure Competition and Efficiency

• Productive efficiencyP = minimum ATC

• Allocative efficiencyP = MC

• Maximum consumer and producer surplus

• Dynamic adjustments• “Invisible Hand” revisited

9-27

Single Firm MarketP

rice

Pri

ce

Quantity Quantity

0 0

Long-Run Equilibrium

P MR

D

S

QeQf

ATC

Productive Efficiency: Price = minimum ATCAllocative Efficiency: Price = MCPure competition has both in

its long-run equilibrium

MCP=MC=MinimumATC (Normal Profit)

P

9-28